Parsa's Organics currently has $56 in debt for every $100 in equity. If the company were to use some of its cash to purchase additional inventory, while maintaining its current equity and net income, which one of the following would decrease?

Question

BlackTom AI · Accepted Answer

Reframe the scenario in your own words: the firm uses cash to buy more inventory, leaving equity and net income unchanged. The key is to see how each financial metric responds to a shift between cash and inventory while total current assets stay the same.
Option 1: Net profit margin. Since revenue and net income are stated as unchanged, the net profit margin (net income divided by sales) remains the same. Making a cash-to-inventory swap does not alter pricing or costs in this setup, so this metric would not decrease.
Option 2: Quick ratio. Quick ratio = (cash + marketable securities + accounts receivable) / current liabilities. By converting cash into inventory, the numerator loses cash but does not gain any quick assets, because inventory is not a quick asset. The denominator (current liabilities) is unchanged. Therefore, the quick ratio would fall
Option 3: None of these. Based on the analysis above, at least one metric does change (the quick ratio), so this option is not correct.
Option 4: Current ratio. Current ratio = total current assets / current liabilities. Although cash decreases and inventory increases, total current assets remain the same, so the current ratio should stay unchanged unless there are other shifts. In this construction, the current ratio does not decrease.
Option 5: Equity multiplier. Equity multiplier = total assets / equity. Since total assets and equity remain constant (only composition of current assets changes), the equity multiplier remains unchanged.
In summary, the only metric that moves in response to converting cash to inventory under these conditions is the quick ratio, which decreases because the numerator (quick assets) falls while current liabilities stay the same.

Parsa's Organics currently has $56 in debt for every $100 in equity. If the company were to use some of its cash to purchase additional inventory, while maintaining its current equity and net income, which one of the following would decrease?Single choice

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